Beneficiaries And 401s Explained
The federal law governing 401 retirement plans is designed to encourage people to use their retirement savings for retirement when they are likely to need financial savings the most.
Under a traditional 401 plan, you may not make penalty-free withdrawals from your plan until you are age 59 and a half. You do not have to take withdrawals at that time, but you can. You must begin withdrawing funds from your 401 every year by the time you reach age 72. This is referred to as your required minimum distribution .
When you pass away, either before or after retirement, the funds in your 401 account will be transferred to whomever you name as the beneficiary of your plan benefits.
Roll Your Money To An Ira
Transfer your money into an Individual Retirement Account .
- Your savings stay invested, with similar tax advantages
- You have access to a wide range of investment options
- You can roll in retirement savings from other jobs
- You can keep contributing money to the account
- Loans aren’t allowed, but you may be able to withdraw money before you retire under certain circumstances
Option : Roll Over Your 401 Into An Ira
Instead of keeping your funds in a 401, you may also choose to roll over your plan into an IRA. Youll do this with a bank or brokerage firm separate from your employer. This is a common choice for people who are leaving the workforce or for those who dont have an employer that offers a 401 plan.
The main benefit of an IRA versus a 401 is more flexibility in withdrawing money penalty-free before reaching the age of 59 ½. You also have direct access and more control over your investment options. You may have other investments and can now move this money to the same brokerage so that everything is in one plan, which consolidates logins.
If you choose to withdraw money from a rollover IRA, it may be used for a qualifying first-time home purchase or higher education expenses in addition to the exceptions for 401s.
The drawbacks of an IRA is that youll lose some hardship distribution options as well as qualified status, which means less protection of your assets. For example, if you were to be sued, some states would allow money in IRAs to be collected but not if it was in a 401.
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You Must Begin Taking Distributions At Age 72
Even if you donât need the money, youâll have to start taking required minimum distributions from your 401 beginning at age 72. The same goes for any other tax-deferred retirement accounts you may have. , you can get around this by converting these funds to a Roth IRA. However, you wonât owe any taxes on the money in a Roth 401, and itâs distributed proportionately.)
The amount youâre required to withdraw depends on your retirement account balances and your life expectancy. While these IRS worksheets can help you do the math, a financial advisor can help you think about how to be effective with your distributions.
Common Pitfalls Of Using Your 401 After Retirement
You ultimately have three options for how to use your 401 after retirement: Receive your funds, keep them intact, or move them to a different type of retirement account. The ideal way to use your retirement plan depends on your financial situation and how you want to use your money, so consider all options carefully.
Failure to conduct a thorough review of retirement fund options can cost you hundreds or thousands of dollars. It can also cause you to face tax penalties or miss out on other potentially high-value investment opportunities.
Meeting with an independent investment advisor can provide an excellent starting point for getting the most value out of your 401. They can help you assess the pros and cons of the myriad ways to use your retirement funds. They can also produce a personalized plan to ensure you can accomplish your financial goals in retirement.
Cashing Out A 401 Is Popular But Not So Smart
Intellectually, consumers know that cashing out retirement accounts isnt a smart move. But plenty of people do it anyway. As discussed, you may be forced out of your former plan based on your account balance, but that doesnt mean you should cash the check and use it for non-retirement-related purposes. In the long run, your financial future will be better served by rolling the money over into an IRA or, if applicable, your new employers 401 plan.
A 2020 survey by Alight, a leading provider of human capital and business solutions, found that 4 out of 10 people cashed out their balances after termination between 2008 and 2017. About 80 percent of those who had an account balance of less than $1,000 cashed out, while 62 percent who had balances between $1,000 and $5,000 did the same.
Based on historical rates of return, a $3,000 cash-out at age 24 leads to $23,000 less in your projected account balance at age 67 a total of 5 percent. Even a small amount of money invested into a retirement vehicle today can make a big difference in the long run.
Do You Have Other Investments Or Retirement Accounts
When planning for retirement, your primary considerations are how much income you’ll need and where the money is coming from. If you have multiple investments and retirement accounts, it’s generally wise to withdraw from taxable brokerage accounts first and tax-deferred accounts, such as your 401, last. Financial planners call this order of liquidation withdraw from certain accounts first while allowing others to continue growing. The idea here is that deferring large tax bills as long as possible could potentially extend retirement savings.
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How To Decide What To Do With Your 401 After Retirement
After you retire, the basic choices you’ll have with your 401 are to keep the money in the plan, transfer your 401 money to another qualified retirement plan or withdraw all or a portion of your 401 balance. While these options are relatively simple, deciding what’s right for you and your retirement goals depends on multiple factors and may require considerable thought and planning.
Some points to consider include other investments or retirement accounts you have outside of your 401 plan, whether you made traditional or Roth contributions and if you’ll be earning other sources of income, such as part-time work, pensions or Social Security benefits.
Here are some questions to ask as you decide what to do with your 401 after retirement:
What Do I Do With My 401 If I Leave My Job
If you’re older than 55 and are no longer employed, you can start withdrawals from your 401 without penalties. If you’re under age 55, you may be able to keep the 401 with your previous employer or move it to a new employer’s plan when you start working again. Talk to the plan administrator about your options. No matter what, don’t abandon your 401 when you change employers.
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How To Avoid Taxes On Your 401k Inheritance
Many 401 plans state that beneficiaries should withdraw all the money inherited in a 401 account in a lump sum. To avoid paying hefty taxes on your 401 inheritance, do not take out the lump sum and deposit it into a non-retirement account.
If you do this, all the money you have inherited from the 401 plan will be subject to income tax the moment you make a withdrawal.
And if you have a sizable amount in your account, chances are that you may end up paying higher taxes. The most ideal thing to do is withdraw the money and deposit it into an inherited IRA account. That way you will be able to control your taxes.
However, keep in mind that according to IRS rules, a lump sum payment should be made before 31st December of the year after the death of the 401 owner. So for example, if a 401 owner died in 2018, the inheritance should be paid out to the beneficiary before or by December 31st, 2019. So it is important that you open an inherited IRA account before the deadline.
On the other hand, you can choose to stick with receiving the required minimum contributions, all you need to do is extend your payouts. When you spread out the withdrawals over a lengthy period of time, it means you are taking out small amounts each year. Doing this ensures that your tax bill is not affected.
Tax Consequences For Beneficiaries
One of the advantages of a 401 retirement plan is that taxes on the money invested in the plan are deferred. This means that as long as the funds are invested and remain in the plan, you will delay your obligation to pay taxes on that income until after you retire and start withdrawing money from the plan.
Likewise, if you die and you have named a beneficiary of your plan benefits, your beneficiary will enjoy deferred taxes on that income until they begin withdrawing funds from the plan. If your spouse is the beneficiary of your plan, your spouse may roll-over the benefits into their own retirement savings plan and continue enjoying the tax-deferred status of that income.
Because you or your beneficiary will be taxed on the amount of income you withdraw from the plan each year, the amount you withdraw will affect your tax bracket and the amount of tax you have to pay on that income. So it is to your advantage to minimize the amount of income you withdraw every year so as to stretch out the tax-deferred benefits of your plan for as many years as possible.
This is why it makes financial sense to name a beneficiary who was young and had a long life expectancy. Their annual required minimum distributions would be lower and their tax-deferred savings would last longer.
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You Have Options But Some May Be Better Than Others
After you leave your job, there are several options for your 401. You may be able to leave your account where it is. Alternatively, you may roll over the money from the old 401 into either your new employers plan or an individual retirement account . You can also take out some or all of the money, but that could mean serious tax consequences. Make sure to understand the particulars of the options available to you before deciding which route to take.
Withdrawing Money From A 401 After Retirement
Once you have retired, you will no longer contribute to the 401 plan, and the plan administrator is required to maintain the account if it has more than a $5000 balance. If the account has less than $5000, it will trigger a lump-sum distribution, and the plan administrator will mail you a check with your full 401 balance minus 20% withholding tax.
Before you can start taking distributions, you should contact the plan administrator about the specific rules of the 401 plan. The plan sponsor must get your consent before initiating the distribution of your retirement savings. In some 401 plans, the plan administrator may require the consent of your spouse before sending a distribution. You can choose to receive non-periodic or periodic distributions from the 401 plan.
For required minimum distributions, the plan administrator calculates the amount of distribution for the qualified plans in each calendar year. The 401 may provide that you either receive the entire benefits in the 401 by the required beginning date or receive periodic distributions from the required date in amounts calculated to distribute the entire benefits over your life expectancy.
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Scenario : Lump Sum Distribution
If you choose a lump sum distribution, the brokerage will withhold 30% from the proceeds if you are a non-resident alien. You may be eligible for a reduced rate if there is a treaty with your home country. Canadians, for instance, are only subject to a 15% withholding tax.
The tax withheld from your 401 proceeds will be applied to your actual tax due in the US. The tax you owe to the IRS may be more or less than the amount withheld. If your actual tax due is greater than the amount withheld, you have to pay the balance. If the amount withheld is more than your tax due, you have to file Form 1040-NR to claim a refund if you are no longer a US tax resident. As far as the US is concerned, once you have moved to your home country, you will only pay US taxes on US-Situs assets if you are a non-resident. Thus, if distributions are small, you could fall into the lowest US bracket and essentially pay 0%.
If your home country requires you to declare and pay taxes on worldwide income, you will have to declare the lump sum distribution as part of your gross Income in your home country, less any credits or exemptions. If there is a tax treaty between your country and the US, you may be eligible to claim actual tax payments in the US as a tax credit in your home country. An experienced tax advisor like MYRA can help you determine the taxes you can expect to owe in retirement.
Leave It With Your Former Employer
If you have more than $5,000 invested in your 401, most plans allow you to leave it where it is after you separate from your employer. If you have a substantial amount saved and like your plan portfolio, then leaving your 401 with a previous employer may be a good idea. If you are likely to forget about the account or are not particularly impressed with the plans investment options or fees, consider some of the other options.
If you leave your 401 with your old employer, you will no longer be allowed to make contributions to the plan.
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Option : Keep Your 401 With Your Old Employer
Many are surprised to learn that in certain circumstances, you can leave your 401 with your old companys retirement plan. However, if you have less than $5,000 in retirement savings, your company may force you out by issuing you a check. If they issue you a check, its crucial that you transfer the funds into a new 401 within 60 days, or else youll have to pay income tax on the distributed balance.
Leaving your retirement savings with your old employer has its drawbacks. For example, you wont be able to make any more contributions to the account, and you may also not be able to take out a loan on your 401. Your old employer may also charge administration fees on the account now that youre no longer an active participant. Additionally, youre still locked in to the funds that plan offers, which may be limited and expensive. For these reasons, many people particularly those new to the workforce choose to roll over their 401 to their new employer.
Pros And Cons: 401 Vs Ira
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Option : Keep Your Savings With Your Previous Employers Plan
If your previous employers 401 allows you to maintain your account and you are happy with the plans investment options, you can leave it. This might be the most convenient choice, but you should still evaluate your options. Each year, American workers manage to lose track of billions of dollars in old retirement savings accounts, so you should make sure to track your account regularly, review your investments as part of your overall portfolio and keep the beneficiaries up to date.
Some things to think about if youre considering keeping your money in your previous employers plan:
What Happens To My 401 If I Move To A Different Country
If you are a foreign worker in the U.S., planning to return home, or a U.S. citizen planning to move abroad, you may be wondering what happens to your 401 account when you leave the country. In this scenario, you have several different options from which to choose.
Leave Your 401 In The U.S.
When you leave your 401 in the U.S., you retain the benefits of compounding your retirement funds. Depending on your age when you leave the country, you could miss out on decades worth of growth if you cash out your 401 and take the funds with you. In addition, you face a 10% early withdrawal penalty if you are under the age of 59 ½, plus income taxes on a substantial lump sum payment.
There may also be tax advantages to leaving your 401 in the U.S., depending on where you are moving. Tax laws can vary from country to country. Other countries may or may not respect the tax benefits of U.S. based 401s and IRAs. If you decide to leave your 401 in the U.S., you can go one of two possible ways.
Keep Your 401 In Your Employers Plan
Roll It Over Into An IRA
Cash Out Your 401
If you choose not to leave your 401 in the U.S. as a long-term investment, you may face tax complications and have administrative issues to deal with. However, you are allowed to withdraw your 401 funds when you leave the country. The funds you withdraw will be considered taxable income, and if you are under the age of 59 1/2, you will also pay a 10% early withdrawal penalty.
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